To Investors: Put Your Money Where Your Bias Is

By Betsy Shaver, VP of Operations

Background Noise

Human beings are messy. Complex. Mercurial. Our life experiences shape who we are and inform how we perceive the world around us as well as how we make decisions while navigating through it. As a result, or perhaps side effect, of our experiences, we all have biases. Say it with me: We all have biases. And whether or not we’re aware of them, they’re always running in the background, like apps on your smartphone or computer.

Did you know there are well over 2 dozen biases recognized by psychologists? Anchoring, availability, blind spot, choice supportive, confirmation, detection of deception, Dunning-Kruger, framing, fundamental attribution error, gambler’s fallacy, halo effect, hindsight, illusion of validity, law of the instrument, optimism, overconfidence, selective perception, self-serving, and survivorship are all scientifically recognized biases that are working in some implicit combination within us, usually without detection. 

These can have obvious consequences, like the last unsuccessful Facebook argument you had with a family member; or why you cling to the hope that “this will be the year” for your sports team. But the effects can also be much more subtle – for example, which investments or entrepreneurs give you a good ‘gut feeling.’  Occasionally, the investment strategy of ‘go with your gut’ pays off; but often, it does not – and sometimes, it can lead even seasoned investors astray – as in the case of Theranos. Similarly, you’ve probably least heard of—if you haven’t already watched—at least one of the Fyre Festival documentaries (if not, you should; it’s a fascinating story). There are countless other stories of investors following their guts to negative outcomes. If you’ve done a handful of investments or more, you may even have one yourself.

Fast vs. Slow Thinking

Why does this continue to happen? Because people make emotional decisions that are informed by their own biases rather than decisions grounded in factual data.  In the video in this link, Daniel Kahneman, widely considered the father of behavioral economics, gives an overview of what he categorizes as “fast-” and “slow-thinking,” which are discussed in greater detail in his book of the same name. He posits that often, what we popularly call our ‘lizard brain’ is responsible for our decision making, which is instantaneous and biased; as opposed to the reasoned, critical thinking that takes place in other parts of the brain.

We see examples of this all the time, for example, in the stark contrast in funding secured by male and female entrepreneurs. Based on the funding women entrepreneurs receive, are we to believe they are only 10% (on the high end) as prepared, competent, or qualified to start a business as their male counterparts? Or is it more likely that most VCs are male, and “see themselves” and/or find male entrepreneurs “more relatable” and therefore more worthy of investment?

The Problem with Biases

Before you say, “Well, that wouldn’t happen with me…I’m not [fill-in-the-blank]-ist” consider taking the Implicit Association Test which will allow you to test for any of more than a dozen biases. Be forewarned that you won’t like your results. I am convinced that no human on earth could take all 16 tests without displaying biases at least half the time. You have them. I have them. Kahneman believes bias is part of the human condition. If this sounds pessimistic, remember that part of undoing biases is first becoming aware that they’re there. When I catch myself in my own biased thoughts, I stop and think, “Wait. Why did I just have that thought?” Or, “Why do I believe that?”  If you want to take it a step further, you can think, “Who benefits from me believing that?” —but that is a whole different post for a different day. 

So what is the solution? In the case of investments, make a data-based decision instead of ‘going with your gut.’ While it is true that you will sometimes be correct, there is the old saying that ‘even a broken clock is right twice a day.” Wait, did you just call me a broken clock? No; I’m saying your ‘gut’ is fallible – as is mine – because it is informed by biases, whether we acknowledge that fact or not.

More to the point, what other decision involving a lot of money would you make without any data? Would you buy a house? A car? Would the bank loan you money just because they have a ‘gut feeling’ you’re good for it? Of course not, because that’s ridiculous. They look at your payment history and credit scores, along with other hard data about you; because the amalgamation of that information predicts whether you are likely to be a worthy credit risk or not. Regardless of how nice (or not nice) a person you are.

People who are entrepreneurs are tangibly different—in outlook, approach, and attitudes, and more—than people who are not. As an example, how would you determine which candidate out of five had the greatest Entrepreneurial Desire (which we know predicts venture success)? Would you know which one of five has the greatest Resilience? How would you know? What if data on entrepreneurs could lower your risk factor? Let’s say your firm went in on 500 ventures. If you could turn just 3% of those from negative to positive, with an average investment of $200K, you’d have a net gain of $3M dollars. The question then is, why wouldn’t you want to use a data-based approach? 

Does your firm want to deploy data-based evaluations of entrepreneurs? We can help.